Interest rates: Credit crunch holding back UK housing market

Confidence growing after peak in Bank of England rates but 'not enough people can get a mortgage'

Leverstock Green, near Hemel Hempstead, England. The Bank of America said defaults on mortgages have plunged because lending criteria have been tightened so strictly as to remove risk almost entirely from the system. PA
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Falling inflation and lower interest rate prospects have led to growing confidence among house sellers but analysts at the Bank of America have warned not enough credit is entering the system to spark a revival.

Prospects for the UK housing market are improving as spring breaks, traditionally an active time for buyers, sellers and estate agents, even as market interest rates remain tight.

Rate cut pushed further out

While the Bank of England (BoE) is widely expected to keep interest rates on hold at 5.25 per cent on Thursday, the rate of inflation fell to 3.4 per cent in February, down from 4 per cent in January, according to latest figures from the Office for National Statistics (ONS) on Wednesday.

There is some speculation that the first cut to interest rates may be further down the line than predicted, due to the reappointment of the well-known hawk, Catherine Mann, to the BoE's interest rate-setting Monetary Policy Committee (MPC). Her tenure on the MPC had been due to expire in August this year but has now been extended until August 2027.

Along with Jonathan Haskel, Prof Mann was one of the two members of the MPC who voted to raise interest rates to 5.5 per cent at the meeting in February.

While confidence toys with over-optimism in the UK housing market, Rightmove noted asking prices were £4,776 ($6,068) below their high in May 2023 and it still took an average of 71 days for properties to find a buyer, the longest for this time of year since 2019.

Watchers of the BoE had believed the first rate cut would come as early as May but that has now been pushed back to August, which means mortgage rates have started to creep up as well.

According to Rightmove, the average asking price of homes coming on to the market rose to £368,118 ($469,110) in March, up 1.5 per cent from February, and the strongest rise in 10 months. It said the average five-year mortgage rate climbed to 4.84 per cent, compared to 4.64 per cent five weeks ago.

Stricter rules, fewer defaults

But the housing market, not only in the UK but across Europe, has been remarkably resilient in recent times in historical terms, for a simple reason: the mortgages in the system were subject to higher standards than in previous times.

“We now seem to be past the bottom of the market,” said Tim Bannister, director of property science at Rightmove.

“For those who can afford to buy and have yet to take action, this may provide a window of opportunity. New sellers are feeling much more confident, with some perhaps being over-optimistic.”

After the 2008 Global Financial Crisis (GFC), regulators forced the banks, which account for 95 per cent of home loans in Europe, to get rid of bad debt. Reducing risk and stress-testing were the name of the new game, which eventually meant the rate at which good loans turned bad slowed dramatically.

Research by the Bank of America shows defaults in mortgages have fallen by as much as 90 per cent compared with a decade ago.

But does this mean people's prospects brightened and they are now less likely run into trouble with their mortgages?

Yes, but that's only half the answer – the number of loans being granted was squeezed as well, due to higher requirements on lenders and borrowers from the regulators.

As such, even though a mortgage might have been advertised as being at 2 per cent when interest rates were low only a few years ago, customers had to prove they could withstand rates at 7 per cent.

"Society is getting too little finance for the safety in the system," said Alastair Ryan, research analyst at Bank of America. "You're not getting enough credit in the system – not enough people can get a mortgage.

"The UK is 1.3 million mortgages short of where it would have been under the rules of finance prior to 2012."

So, while the UK's banks are certainly stable and have much larger capital buffers than they used to, there's an economic and societal cost to safety. Banks in the post-GFC world are smaller, Mr Ryan said and "there's too little risk in banking".

While a lot of risk is undesirable and, when obscured, can lead to situations such as the US subprime crisis that almost took down the world's banking system, a little risk is necessary for growth. Remove risk completely and you remove growth completely.

Number crunching by the finance website puts the current average age of a first-time buyer in the UK at 34. In 2012, that first-time buyer was 32 and in 2007 he or she was 30.

The total number of UK first-time buyers fell by 11 per cent between 2021 and 2022, while the average deposit they paid was £62,470 in 2022, up 8 per cent from 2021.

However, the average deposit for a first-time buyer in London in 2022 was more than double that, at £125,378.

Shock absorbers

The continued derisking of the banks over the past 12-14 years has meant riskier borrowers have been excluded from accessing the property ladder and ensured that those with mortgages could absorb shocks such as rising inflation and interest rates.

This, the Bank of America said, gives the housing market a completely different nature to that which existed previously, one with far less stress.

"No distressed sellers, no distressed banks means the impact of monetary tightening on housing is already in the rear-view mirror," the bank's research said.

"Home prices up in 2024 will contrast with central bank expectations of long-tail weakness in housing – and banks will lend into that demand."

Basically, the argument is that more lending is needed, which implies more risk. The banks are keen to lend, while the regulators and politicians are keen to keep the system tight and safe.

Back in the immediate aftermath of the GFC, senior figures in the City of London's financial world talked of stability of the banking sector being desirable but what was to be avoided was the "stability of the graveyard".

Back in 2012, the then-chairman of the UK's Financial Services Authority, Adair Turner, said Britain's financial system faced "at least a potential short-term trade-off between [bank] resilience and lending".

Risk and growth

Arguably, regulations such as much higher capital requirements and stringent stress tests protected the housing market and borrowers from the economic shocks of the last few of years and defaults on mortgages were kept relatively low.

"Banks are not better lenders than they used to be, they just lend to different people," Mr Ryan said.

"Those 1.3 million missing UK mortgages – those are all riskier borrowers. Those are people who could not meet the 7 per cent interest rate stress, or didn't have the 20 per cent deposit or [the house price] was more than 4.5 times their income.

"So, those people didn't get a home and the bank can't lose the money, because they didn't give the money out.

"And because the banking system is so less risky, those borrowers didn't get loans and you don't get the recession you did before."

Conversely, it also means loan growth for UK banks over the past 15 years has been next to nothing, according to the Bank of America.

The high cost of capital among Europe's banks is holding back lending and as such holding back growth, Mr Ryan said.

"I look at the banking system today and it seems to have less risk than at any time in the last 60 years. And it has low growth. The two are linked."

Updated: March 20, 2024, 9:03 AM